Prior Equity Responses to 2yr-10yr Treasury Yield Curve Inversions

The focus this morning has been on the latest development in fixed income with the 2-year Treasury Yield rising above the 10-year Treasury Yield. This is an input in many economists recession models and provides insight into the sentiment of the bond market. While my focus isn’t on the implications of the inversion, what I care about is what happens to the equity market when the curve inverts. In March I wrote about the prior inversions of the 3-month and 10-year inverting, noting the results are mixed but many times the equity market continued higher.

First let’s look at all the prior times the 2yr crossed above the 10yr since the 1970s. This obviously hasn’t occurred since 2007 but it did flip well before the market peaked and kicked off the GFC.

Next lets filter the results down to when the S&P 500 was within 10% of an all-time high. Our sample size begins to shrink quite a bit now and the picture looks a little less rosy. The ideal period of history we’re we last saw an inversion with stocks near an all-time high was in 1998, which also brought with it an interesting period of geopolitical history with the implications of foreign currencies taking some spotlight.

So now what? The implication of the 2-10yr curve inverting will scare some people. The idea that it’s associated (wrong or right) with recessions will cause some investors to act emotionally. Regardless of what the actual inversion means for the market or the economy, what matters is the reaction to it. Looking at the short-term price reactions after inversions since 1970, the trend has been fairly flat three months out. I tweeted out a chart on this topic, showing the median return was -1.86%. Price action will give a clear view of that reaction, giving yet another reason to stay focus on the data and not the narrative surrounding this small sample sized development.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.

About Andrew Thrasher, CMT

Andrew Thrasher, CMT is a Portfolio Manager for Financial Enhancement Group, LLC, an asset management firm in Central Indiana and founder of Thrasher Analytics, an independent financial market research firm. He specializes in technical analysis as well as macro economic developments.